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What is due diligence?

 

The term due diligence is often mentioned when you are looking at purchasing such items as real estate or a business. If you have no prior experience purchasing items of this complexity, you may not really know what due diligence is and, in essence, how much diligence is due for a specific transaction.

For instance, if you are buying a residential property for a first time, you may not realize that unlike many purchases, such as buying a motor vehicle or a television, your rights after a sale are very different. With the exception of statutory disclosure violations, a buyer has very little recourse to a seller if they failed to properly investigate potential issues with a property.

 

The same is true for a business. Due diligence demands that you, as a buyer, make reasonable inquiries about your transaction. What is reasonable and how much diligence is due, however, will depend on the transaction, and the more complex the deal, the greater time and financial commitment you need to make for due diligence.

When you purchase a business, you should review the location, sales and other measurements of the businesses performance, such as staffing needs, cash flow and expenses. You should also consider the general neighborhood, any changes to the layout or structure that could be necessary and the procedure needed to obtain approval for such changes.

Are there covenants, easements or zoning ordinances that apply? If you need to change part of the building, do your need approval of any other entity, such as the property owner, tenants association or municipal zoning board or commission? Are there any plans for major road construction in the area that could affect traffic to your business and your cash flow?

Sometimes a buyer will try to minimize their costs and skip some of these investigations, only to later find that they present significant problems, either in terms of bureaucratic procedures, the need for substantial physical repair or litigation costs. 

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